Price Destruction In Cattle And Hogs May Lead To An Opportunity (NYSEARCA:COW)
Commodities fundamentals are the supply and demand fundamentals of a market that provide clues about the path of least resistance of prices. We are currently in the midst of a deflationary storm where the prices of many assets have declined dramatically. Unprecedented monetary and fiscal stimulus is working overtime to stabilize markets until scientists come up with effective treatment and vaccine to end the nightmare of Coronavirus.
Meanwhile, the vast majority of the United States is staying at home to slow the spread of the illness that continues to infect people and claim the lives of the most vulnerable. This week, my wife and I went food shopping. The social distancing guidelines have created lines outside supermarkets that remind me of my trips to Russia in the late 1980s. At the same time, some of the aisles are still bare with shortages of items like toilet paper, paper towels, disinfectant wipes, and others. Over the past month, there have been shortages of supplies of beef, pork, and chicken as consumers stocked freezers across the US. Based on the prices of cattle and hog futures, there should be more than enough to satisfy demand as the animal protein markets have sunk to multiyear lows.The iPath Series B Bloomberg Livestock Subindex Total Return ETN product (COW) moved higher and lower with meat prices. The last time I wrote about meats and the COW product on Seeking Alpha was on February 11 when I wrote about wet markets in China that could have launched the global pandemic. Since then, the prices of beef and pork futures have tanked.
Cattle fall to the lowest price in a decade
Before March 2020, critical long-term support for the price of live cattle futures stood at the 2016 low of 94.30 per pound. The bottom came in October 2016, at the end of the peak season for demand during the summer months.
As the monthly chart highlights, the impact of Coronavirus on markets pushed the price of live cattle on the continuous chart to a low of 83.825 cents per pound, a level not seen since December 2009 when they traded to a low of 78.70 cents. The cattle futures bounced from the most recent low and were trading at just over the 92 cents per pound level on April 9.
Price momentum and relative strength indicators on the long-term chart continued to display a bearish price trend. Open interest, the total number of open long and short positions in a futures market, fell from 378,966 contracts at the end of 2019, when the price was at the $1.2470 per pound level, to 266,587 contracts as of April 8. The decline of 112,379 contracts or 29.7% when the price is falling is not typically a technical validation of a sustained bearish price trend. However, 2020 is anything but an ordinary year.
The daily chart of June live cattle futures shows that the price dropped to a low of 76.60 on April 6 before recovering to just below the 84 cents level on April 8. The low in June was the lowest price since 2006.
Hogs decline to an eighteen-year low
In 2016, lean hog futures fell to a multiyear low of 40.70 cents per pound on the back of a glut in the pork market. The low came in October, one month after the end of the 2016 grilling season, the peak time of the year for demand.
The monthly chart illustrates that in April 2020, the continuous contract price fell to 37.50 cents per pound, the lowest level since 2002. As in the cattle futures market, both price momentum and relative strength continued to point lower with the price at just over the 42 cents per pound level on April 9. Open interest fell from 282,358 contracts at the end of December 2019 to 230,049 contracts on April 8, a drop of 52,309 contracts, or 18.5%. In both cattle and hog markets, the deflationary spiral caused many market participants to move to the sidelines, sending the open interest metric lower.
As the daily chart shows, nearby June lean hog futures recovered just over 49 cents per pound on April 9.
Demand destruction with abundant supplies
The price action in the animal protein markets is no different than what occurred in markets across all asset classes. The price of crude oil dropped from $65.65 per barrel in early January 2020 to its most recent low at below $20 per barrel in late March. Grain and many other agricultural commodity prices also experienced significant price declined over the past weeks. When it comes to grains, lower prices decrease the cost of animal feed leading to higher carcass weights at processing plants and greater overall supplies.
Meanwhile, the overall landscape of falling demand for all products as people in the US and around the world remain at home sheltering in place to slow the spread of the virus has weighed on the prices of live cattle and lean hog futures.
The grilling season is less than two months away
The peak season for demand in the animal protein sector is now under two months away. The Memorial Day Weekend in the United States marks the unofficial start of the summer season, which is the time when many people take their barbecues out of storage. From the Memorial Day weekend through the Labor Day holiday in early September, the aroma of steaks, burgers, hotdogs, ribs, and other proteins full the air as they sizzle on grills. The uncertainty over the spread of Coronavirus into the summer months, and the potential for a continuation of social distancing, is likely to mean fewer summer barbecues and less demand for beef and pork. Therefore, prices currently reflect the poor prospects for demand and high levels of supplies going into what has been the peak season in past years.
COW is the meat ETN product- Low prices are an opportunity for a recovery
I have had more than a few Coronas at summer barbecues over the years. Ironically, it will be another kind of Corona that precludes those gathering over the coming months.
Prices of cattle and hog futures have already declined to the lowest level in over one decade in the case of beef and almost two decades when it comes to pork. Expect lots of sales over the coming weeks and months as those shortages in the butcher section in supermarkets over the past few weeks turn into a glut of inexpensive meat offerings.
Meat prices dropped to levels that were either long-term bottoms or close to those levels. On any further price weakness, live cattle and lean hog markets could become too inexpensive to ignore. Moreover, the potential for export problems from South America could create shortages over the coming weeks and months. While low grain prices are likely to make supplies in the US increase as carcass weights rise, cattle and high prices at levels where they have bounced sharply in the past. At the same time, today’s glut conditions do not guarantee oversupply in the future as the shelf life of beef and pork is not the same as in many other commodities like copper and crude oil.
The most direct route for a risk position in the meats is via the futures and options markets. Meat futures can be highly volatile and illiquid at times, which can lead to price gaps on the up and downside. For those looking for exposure to the price of livestock without venturing into the futures arena, the iPath Series B Bloomberg Livestock Subindex Total Return ETN product (COW) provides an alternative. The fund summary for COW states:
Source: Yahoo Finance
COW has net assets of only $7.01 million, trades an average of 21,455 shares each day, and charges a 0.45% expense ratio. COW’s low level of net assets causes bid-offer spreads to be wide. For positions in meats using COW, I would leave standing orders at desired levels, and be cautious with stops as the illiquidity can lead to stop-hunting by algorithms. Prices around 40 cents per pound in hogs and 80 cents in live cattle likely limit the downside potential making these meats assets to put on your investment radar.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.